(April 5, 2012) — The Co-Head of Asset-Liability Management at Pension Corporation, one of the more successful companies that sprang up in the clamour to derisk defined benefit funds in the last decade, says that refusing to look on the bright side is essential.
“You always have to look at the downside,” says Gull, who has a twenty-year history managing fixed-income. “You have to be risk aware – you can take risk, but you have to manage risk and understand how it all interacts. Everything is not always just going to move in a straight line.”
Pension Corporation takes on the assets and liabilities of pension funds and manages them to conclusion. Their annual report last week showed they are responsible for £4.7 billion and the retirement income for almost 55,000 members.
With this kind of responsibility that has been entrusted by third parties, the company has a fiduciary, and contractual duty to be risk aware. Going into the worst of the financial crisis, some 75% of the company’s portfolio was held in cash.
“This is the Pension Corporation ethos – we think it is blindingly obvious to try not to lose money and that the upside does not look after itself; it still has to be managed.”
With that in mind, Gull and his team have taken to covered bonds in recent months. These debt instruments are backed by collateral, usually residential mortgages, that can be taken should the debt issuer default.
They tend to produce a lower return than conventional unsecured bonds, but are more secure and make a huge amount of sense, according to Gull. The company has brought this asset class in-house. With £4.7 billion balance sheet assets, they are now able to go direct and source these instruments in the capital markets rather than use a fund manager. Corporate index-linked and now covered bonds are run in-house on a ‘buy-and-hold’ strategy. Gull said the company was taking advantage of new regulations that were shaking up what banks could hold on their balance sheets.
Long-term loans, some of which are backed by high grade sellers are coming to the market with attractive price tags from these forced sellers.
However, a good chunk of the Pension Corporation portfolio (mainly credit assets) is outsourced with third party managers looking after a small alternative allocation to insurance-linked securities and private equity, for example.
“We want our alternative managers to be genuine alternatives,” Gull assets. “If they are making money and losing money in line with the rest of our portfolio, that’s not what we want – that means they are correlated and not improving the risk profile of the portfolio.
“Also if one of our managers suddenly starts to overperform – we at least ask them what they are doing as they may be taking too much risk for our liking.
“Returns come over time – we are farmers not hunters – we have long-term liabilities, stretching at least 70 years,” he says.
The returns are coming though. In 2011, Pension Corporation reported a £17 million profit despite a volatile market – although this was down on the 2010 profit of £81 million due to ultra-low gilt yields.
The volatility is only part of the current tricky market environment though, according to Gull, who has been vocal in the UK financial media explaining what he thinks is wrong with the current policy to straighten out the economy.
He has criticised the policies of the Bank of England of its quantitative easing as it has depressed long term gilt yields, but praised the Troubled Asset Relief Programme (TARP) in the United States.
“Europe has not addressed the problem with the LTRO – but banks should be able to run a carry trade for a bit, which should enable them to make profits in the short term.”
The problem for investors is not just a purely financial one though, according to Gull.
“The population of the developed world is changing – the growth element was partly fuelled by borrowing, this means that the growth trend will be lower in the current 25 years than it was in the last. In the current environment we have low inflation, low trend growth and debt in both the government and private sector.”
All this has a knock on effect to how investors should allocate their assets.
“Investment grade corporate bonds are a great asset class in this environment – it’s not a great equity story. We don’t really invest in equities; we are looking for more assets that have less volatility.”
Pension Corporation, along with many other pension investors in the UK, is taking a serious second look at infrastructure.
“There is a need for infrastructure debt; if it is index-linked it can provide a real yield above expensive gilts the model for investing there (in infrastructure) is changing. Longer term lending is getting more expensive for banks as banking regulation takes a dim view of it. The model had to change: banks were keeping all the debt in house or private equity companies were using a level of leverage they just can’t access now.”
Emerging market corporate debt is interesting to Pension Corporation too, Gull says, as these countries usually have a lower level of debt than their developed counterparts.
After the flurry of buyout companies that burst on to the scene in the mid-2000s largely disappeared or were absorbed into competitors, Pension Corporation seems to have struck the right note, even if at first glance it seems a sorrowful one.